In the run up to most Budgets it is common to hear rumours suggesting some form of cut to pensions tax relief, however, this year it seems more likely than usual. We have a new Government with a significant majority, who have promised large scale spending on public services and they will need to raise some funds from somewhere. Pensions tax relief is expensive and so may be too big a target to resist.
We also have a brand-new Chancellor who may not have previously been involved in understanding the complexity and potential unintended consequences of cutting pension tax reliefs.
The strongest rumour to emerge at the time of writing is the cutting of tax relief for higher rate taxpayers. There are several issues with this idea including how it would work with net pay contributions, employer contributions and defined benefit schemes. It also isn’t clear how this would tie in with the Government’s promise to resolve the NHS staffing issues caused by the impact of pension taxation.
Whether we will see any changes or not, it is often good planning to ensure pension contributions are maximised before the end of the tax year and for this year ensuring contributions are made before 11 March Budget Day may be worthwhile just in case any changes are introduced with immediate effect.
As well as affordability, the restrictions to pension contributions are the client’s available annual allowance (including any carry forward relief) which applies to all contributions, and, where making personal contributions, their level of earnings.
The annual allowance can now vary from anywhere between £4,000 for someone who is subject to the Money Purchase Annual allowance, all the way up to £160,000 where the client isn’t subject to tapering and has the maximum carry forward allowance available.
Personal contributions are also limited to the higher of £3,600 gross and the client’s relevant UK earnings, which primarily means any income earned from employment or trade and doesn’t include investment income such as dividend income or rental income (apart from certain holiday letting income).
Within these limits, making contributions to maximise contributions that at least receive higher rate tax relief maybe worthwhile. It is worth remembering that whilst investment income doesn’t count as relevant earnings, pension contributions can still be used to obtain higher rate tax relief on that income. For example, if someone has £50,000 of earnings and £10,000 of rental income, a £10,000 gross pension contribution will ensure all the rental income moves from being taxed at 40% down to 20%.
For tax year 2019/20 any carry forward available from 2016/17 needs to be used or it will be lost. In order to use it contributions need to be made that, firstly, are enough to use up the current year’s annual allowance. Once the current year’s allowance has been used the rules ensure additional contributions then use the earliest carry forward year first.
As well as receiving tax relief at the client’s highest marginal rate there can be additional tax benefits of pension contributions for some clients as they can be used to reclaim the personal allowance where income exceeds £100,000, and avoid the high income child benefit charge where income exceeds £50,000. The income definition used for both of these is “adjusted net income” and pension contributions will reduce this figure whether they are made by net pay (i.e. a gross contribution deducted from earnings) or by relief at source (i.e. paid net of basic rate tax). Where contributions can restore allowances or avoid charges the effective rates of tax can be 60%, or more, making pension contributions even more attractive.
There is only a short wait now until we see if there are any significant changes to pension tax relief or if, once again, the rumours are deferred until the next Budget. However, where a client can achieve higher rate tax relief or greater it may be worth maximising contributions while we know it’s still available.